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Stimulus will take a while to work

Amid all the anticipation of Obama's stimulus package, Americans should realize that its effects aren't likely to be felt until the economy is already rebounding on its own.

By Anthony Karydakis, contributor
Last Updated: January 12, 2009: 11:47 AM ET

(Fortune) -- The roll-out of the Obama Administration's fiscal stimulus package has been met with a huge amount of anticipation, heightened by a lack of specifics, which seem almost purposely elusive as a signal to Congress that this is essentially a draft open to discussion. However, the buildup of such expectations over the outcome of this process creates a distinct risk in casting the fiscal package as a near panacea for pulling the economy out of its current deep slump.

With the economy in such a tough bind, there is tremendous pressure on the incoming Administration to show strong action on the fiscal front, of the pulling-out-all-the-stops variety. But the reality, based on hard facts on the ground and the quirky dynamics of fiscal policy, suggest that the potential of such a package to turn the economy around in any meaningful way in 2009 is actually quite limited. In fact, it is nearly impossible to alter the trajectory of economic activity over the next two to three quarters, fiscal stimulus or not.

In other words, over that time frame, the economy will simply do what it is already on track to do, which is essentially to experience additional contraction. Among the many factors: corporate capital-spending plans for 2009 have already been downgraded and are not easily amenable to meaningful improvements, the rest of the industrialized world is likely to remain in a recessionary environment that hurts U.S. exports, and American consumers have grown increasingly anxious over job prospects, which will keep their spending habits on the defensive.

The main obstacle to the ability of fiscal-policy measures to influence the path for the economy this year is that they usually require a frustratingly long amount of time to work their way through the system. President-elect Obama's claim that his economic team has, in collaboration with governors around the country, already identified a significant number of infrastructure projects that are ready-to-go once funding is approved, is encouraging on the face of it. But it needs to be viewed with some caution. The sheer scale of the spending involved makes it hard to identify enough such projects that can be immediately implemented.

In fact, this poses a distinct risk that would undermine Obama's recent statement that he has extracted a promise from Congressional leaders that the fiscal package, in an effort to eliminate wasteful spending, will not contain earmarks. In the rush to spend a large, pre-committed amount of money, projects of dubious quality and long-term value to the economy will start creeping into the package. The side effect of that prospect is that at least a portion of the total fiscal package may have very minimal contribution to economic activity over the next year or two. Differently put, bridges-to-nowhere may well be a quick way to spend the money but do little to set into motion a productive expansionary dynamic for the broader economy.

All in all, the legitimate infrastructure spending, which in its expanded form would include Obama's ambitious plans to invest heavily in renewable energy sources, will most likely not start coming on line until the fourth quarter of the year and its full effect is at least 12 to 18 months away. In other words, the fiscal stimulus measures that the incoming Administration will be pushing through are more a 2010 story.

The same needs to be recognized regarding the new President's assertion last week that his economic stimulus plan will create or save between 3 and 4 million jobs over the next two years. Even if these numbers were to be momentarily accepted at face value, the job creation almost certainly be heavily back-loaded. It's precisely for that reason that the Obama team is referring to such expected outcomes over the time frame of the next two years, carefully refraining from attaching a specific estimate to 2009 alone.

This prospect brings to the forefront a historically well-established shortcoming of fiscal-stimulus packages, which is that they produce results too late to alleviate the near-term pain and, actually, tend to take effect when the economy is already in the process of recovering on its own and needs such help the least -- leading to a potential overheating of economic activity at that time. This is what has at times been aptly described as the "curse" of fiscal policy.

Political reality is another complicating factor diminishing the potential effectiveness of the fiscal package. Obama's plan reportedly will contain about $300 billion of tax cuts in an attempt to attract Republican support in Congress. However, based on preliminary reports, roughly half of that amount would be given to corporations that would agree to refrain from layoffs, or to hire more workers. While carefully calibrated consumer-targeted tax cuts generally have a useful role to play in stimulating economic activity, corporate tax breaks to entice employers to retain workers in the midst of a deep recession are of highly questionable value. The demand for the products that such workers will be generating is dismally weak, severely undermining the willingness of corporations to play along with the originally intended idea.

The total size of the fiscal package itself has been reported in the vicinity of $800 billion, but this should definitely be viewed with a grain of salt. What will finally emerge from the process in Congress over the next two weeks could be materially different, almost certainly more expensive than this number. In what is perhaps a convoluted kind of logic, the fact that the new Administration is already inheriting a massive budget deficit in the $1 trillion to $1.5 trillion range in the current fiscal year has blunted any prior sensitivity to budget-busting fiscal measures, providing the Obama team and Congress with virtually a carte blanche regarding the size of the stimulus package.

Even more critical will be the structure of the final package and the balance between its components -- the mix of spending and tax cuts. It would be a refreshing break from the past if both the Administration and Congress (particularly the latter) grasp the opportunity that the depth of the current recession affords. In that spirit, to lay the foundation for the comeback of the U.S. economy, the final version of the package would need to stay clear of pork-related spending and gimmicky corporate tax credits. This is precisely where our attention and scrutiny should turn in the coming days, as the generalities slowly dissolve and are replaced by a stream of concrete measures.

Anthony Karydakis is a former chief U.S economist for JP Morgan Asset Management and currently an Adjunct Professor at New York University's Stern School of Business. To top of page

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